For the last couple years while I have been out at various social gatherings, I inevitably get into that conversation with people wanting to know why I still talk about having a globally diversified portfolio. It is typically pointed out that the U.S. markets have been doing so great and the international markets are not. On the surface that is true.
Last year the S&P 500 returned about 15% for the year while the MSCI EAFE (representing the developed international markets) lost about 4% in U.S. dollars. Big difference, but what most forget is that these double digit returns that the S&P has put up over the last few years are more of an anomaly than a norm. Historically the average annual return for the S&P 500 is 7%.
That said, negative returns in the international markets are also not the norm. Interestingly enough, though posted as a negative return when the returns were translated in U.S. dollars, the returns were actually positive by almost 7% when you take the U.S. dollar out of the mix and look at them in their local currency. Why the big difference in numbers? All you heard about last year was the strong U.S. dollar and the dollar hitting these high levels. You sat back being all patriotic and thinking that is great, while you are chanting “USA, USA, USA”. Then you get your account statement for the international index fund you are invested in and wonder what happened. Well the answer is kind of simple. When you invest overseas your investment, while made in U.S. currency, appreciates over a certain period of time. However when you want to know how it is performing, you want that translated back into U.S. dollars. As the dollar is getting stronger it is making other currencies weaker and those international companies you invested in operate in those weakened currencies. Does that mean your company actually performed poorly? No. But when you exchange those returns back to today’s dollars rate, they are not worth nearly as much. It wasn’t the company, it was the exchange rate. Keep in mind, the inverse can happen when the U.S. dollar gets weaker.
So, this would sound like while the U.S. dollar is strong, you want to stay away from international investing. Well, that is actually not the case either. A strong U.S. dollar is also bad for U.S. companies that do business overseas, as many of them do. It becomes much more expensive for U.S. companies to operate overseas and the money they do make then has to be translated back into the strengthening U.S. dollar. Conversely, it becomes much more affordable for international companies to operate with other international trading partners, particularly the United States. Weaker currency is actually a good thing for countries that are trying to turn their economy around.
So, how is that translating into your international investments this year, because the U.S. dollar is still at similarly strong levels like last year? Well, when translated back to U.S. dollars, that index fund( that you are hopefully still invested in) that tracks the MSCI EAFE is returning a little over 8% year to date (as of July 17, 2015). Remember we are only at the half way point of the year. Now translate that back to the just under 14% return that same index is returning in those companies local currencies. This shows that the weakened currencies are indeed helping those markets. This is even with all the talk about Greece and a weak China.
So why do I still push for an internationally diversified portfolio? Year to date, even with the effects of the strong U.S. dollar that we are still experiancing, the MSCI EAFE is returning around 8%, while the S&P 500 is just under 4.5% for the same period of time. Holding onto those international investments are helping your portfolio this year.
Don’t try to time it, just be in it and in the long run you will be rewarded.